Question

Balloons By Sunset (BBS) is considering the purchase of two new hot air balloons so that it can expand its desert sunset tours. Various information about the proposed investment follows: (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided.) Initial investment (for two hot air balloons) $ 408,000 Useful life 7 years Salvage value $ 51,000 Annual net income generated 37,536 BBS’s cost of capital 8 % Assume straight line depreciation method is used. Required: Help BBS evaluate this project by calculating each of the following: 1. Accounting rate of return. (Round your answer to 2 decimal places.) 2. Payback period. (Round your answer to 2 decimal places.) 3. Net present value (NPV). (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round the final answer to nearest whole dollar.) 4. Recalculate the NPV assuming BBS's cost of capital is 11 percent. (Do not round intermediate calculations. Negative amount should be indicated by a minus sign. Round the final answer to nearest whole dollar.)

1.Accounting rate of return 9.20%

2.Payback period 4.61years

3.Net present value ?????

4.Net present value assuming 11% cost of capital ???

Answer 1

3. Cost of capital=8%

Net present value is calculated by : Present value of cash inflows- Total initial cash outflows

Present value of cash inflows will be: Annual cash flows* PVIFA(8%,7 years)

                                                      =37536 * 5.2064

                                                      =$195427.43

Present value of terminal flow i.e. salvage value= 51000* PVIF(8%, 7 years)

                                                                    =51000* 0.5835= $29758.5

Total present value of cash inflows= 29758.5+ 195427.43= 225186(approx.)

Initial cash outflow= $204000(for one)

Net present value= 225186-204000= $21186

4. If cost of capital is 11%

Present value of cash inflows will be: Annual cash flows* PVIFA(11%,7 years)

                                                      =37536 * 4.1722

                                                     =$156607.7

Present value of terminal flow i.e. salvage value= 51000* PVIF(11%, 7 years)

                                                                    =51000* 0.4817= $24566.7

Total present value of cash inflows= 24566.7+ 156607.7= $181174.4(approx.)

Initial cash outflow= $204000(for one)

Net present value= 181174-204000=($22826)